(Bloomberg) -- The UK Treasury warned that even a small fiscal stimulus may cause interest rates to jump by as much as 1.25 percentage points, a rebuttal to Conservative members of Parliament calling for sweeping tax cuts ahead of a general election.
It said in a policy paper released on Friday that increasing borrowing by £25 billion ($32 billion), or 1% of GDP, can result in rates rising by 0.5 to 1.25 percentage points. That’s a much bigger impact than previous estimates from the Office for Budget Responsibility and International Monetary Fund.
The Treasury said prices and interest rates may currently be more sensitive to stimulus due to Britain’s persistent inflation problem.
The findings come after pressure from Tory MPs to slash taxes in a bid to revive the party’s low poll ratings ahead of a general election widely expected next year. Britain’s headline inflatinon rate at 4.6% is the highest in the Group of Seven nations.
Chancellor of the Exchequer Jeremy Hunt announced some personal and business tax cuts at the Autumn Statement last month. However, the OBR judged that these would only have a minor impact on inflationary pressures.
The Treasury paper highlighted was that largess from the government could feed through to higher inflation, requiring further action from the Bank of England.
“An unanticipated increase in spending, or reduction in taxation, that is funded by additional government borrowing, will increase the level of demand in the economy,” the Treasury paper said.
It cited previous studies by the OBR and IMF suggesting a 1% of GDP increase in borrowing would lead to a boost to rates by around 0.5 percentage points.
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